ECB asset purchases: not proportionate, yet

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●  ECB policy supportive for even longer: In response to the economic fallout of the COVID-19 pandemic, central banks, including the ECB, shifted to “whatever it takes” mode. Together with other factors, this has underpinned a surge in equity markets over the past three months. In this note, we point out that the ECB may remain as supportive as it currently is for even longer than commonly expected.

●  Inflation – back at the top of the agenda: One of the ECB’s most important decisions at its 4 June meeting was to evolve the purpose of its pandemic emergency purchase programme (PEPP). After initially providing ample liquidity to prevent a financial crisis, the ECB is now focusing more on the medium-term inflation outlook again.

●  Projections contain crucial forward guidance: The refocus on the inflation outlook puts the spotlight on the ECB’s own inflation projections. They provide strong forward guidance as to what the ECB may do going forward. In response to the biggest downgrade in the history of the projections, the ECB took steps that will allow it to maintain a very loose stance for roughly six more months.

●  The June meeting – not the final act: While a beefed-up PEPP will limit the downside risks, it may not be proportionate to let the “inflation outlook robustly converge to a level sufficiently close to, but below 2%” within the ECB’s forecast horizon. The ECB’s own research on previous asset purchases suggests that the June decisions may have only a small impact on inflation. The current inflation projections may still be too optimistic. If so, the ECB would need to do more than it already plans in response to its June downgrade of inflation. While this time is a bit different, since very supportive fiscal policy may add to price pressures by more than in the past, the extraordinary financing needs of governments still require very favourable financial conditions.

●  A matter of time until ECB comes up with more: Eventually, the ECB will likely take further steps to maintain its very loose monetary stance for quite a while. Most of its instruments are maxed out. As a result, further envelopes of asset purchase commitments will remain the first line of action. Whether the ECB would make these asset purchases under PEPP or the more standard asset purchase programme (APP) would not matter much for the inflation outlook.

●   A trillion more to come? Markets seem largely to expect the ECB to increase its PEPP envelope for the second, but last, time by €500bn-600bn later this year. We think the ECB may do more, in a series of steps, and commit to purchases that could total €0.8trn-1.6trn over the next two to three years beyond what it has planned to as of now. The size will ultimately depend on: 1) the inflation outlook; 2) the effectiveness of the ECB’s long-term loans; and 3) the currently paused strategy review.

Florian Hense

European Economist

+44 797 385 2381

florian.hense@berenberg.com

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This material is intended as commentary on political, economic or market conditions for institutional investors or market professionals only and does not constitute a financial analysis or a research report as defined by applicable regulation. See the "Disclaimers" section of this report.

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